Managing The Dragonhttp://www.managingthedragon.com
Business in China - From the Ground UpWed, 22 May 2019 12:52:51 +0000en-UShourly1https://wordpress.org/?v=5.0.4The U.S.-China Trade War Enters Uncharted Watershttp://www.managingthedragon.com/?p=2812
http://www.managingthedragon.com/?p=2812#respondTue, 21 May 2019 02:41:39 +0000http://www.managingthedragon.com/?p=2812In the five predictions we made for 2019 at the beginning of the year, our first and most important was that the trade war between the United States and China would be successfully resolved by June 30. U.S. President Donald Trump and China’s President Xi Jinping are scheduled to meet at the G20 Summit in Osaka, Japan, on June 28, so our prediction may still turn out to be correct. However, I am not quite as confident as I was earlier this year. My fear is that, while the Chinese negotiators may have underestimated Trump’s resolve to fundamentally change the Sino-U.S. relationship and use tariffs as a means to that end, the U.S. negotiating team may have gone down a wrong path by trying to write intellectual property rights (IPR) protections into Chinese law, underestimating Chinese resistance to interference by foreign powers in the internal workings of its government in the process.

On Sunday, May 5, just before the 11th round of U.S.-China trade talks were set to begin in Washington, President Trump surprised everyone when he tweeted that the United States would raise tariffs on $200 billion of Chinese goods from 10 percent to 25 percent on May 10 if he did not see satisfactory progress in the talks. Without actually being part of the negotiations, it is difficult to say precisely what caused the sudden reversal in the discussions between the two countries. Whatever triggered his tweet, however, President Trump was clearly frustrated by the slow progress of the negotiations.

On September 24, 2018, the United States imposed 10 percent tariffs on $200 billion of goods imported from China, with a scheduled increase to 25 percent on January 1, 2019. One result of the very positive dinner that President Trump and President Xi had in Buenos Aires on December 1, 2018, was the postponement of the increase until March 1, 2019. After a number of rounds of seemingly productive negotiations in the months that followed, President Trump once again postponed the imposition of higher tariffs when he reported that the United States and China had made “substantial progress” on important structural issues, including intellectual property protection, technology transfer, agriculture, services, and currency. Assuming that both sides made additional progress, a summit at Mar-a-Lago was being planned to conclude an agreement.

Although the trade negotiators continued their talks in both Beijing and Washington, the Mar-a-Lago summit never happened. Then, on May 10, trade talks took their recent turn for the worse when Trump made good on his threat to raise tariffs, and China retaliated with increased tariffs on $60 billion of goods from the United States. Many explanations have been given for the breakdown in negotiations, but at the core, it would appear that both the Chinese and the U.S. negotiating teams seriously misjudged their counterparts.

Reports say that talks stalled after China tried to delete commitments from a draft agreement that its laws would be changed to enact new policies on issues ranging from intellectual property protection to forced technology transfers. Reportedly, the Chinese negotiators sent the United States a substantially rewritten draft agreement, which led President Trump to accuse Beijing of reneging on settled terms and to threaten higher tariffs. If that is indeed what happened, it will not be the first time that the terms of a deal have been changed at the last minute in China. In fact, a common complaint of foreign executives trying to do business in the country is that negotiations never seem to end. Just when you think you have a deal, it changes.

The difference in this case, though, is that, unlike a company that wants access to the China market and has relatively little leverage, the United States is China’s largest market, and Chinese exporters sell over $500 billion to U.S. customers every year. At the same time, U.S. exports to China are substantially less at about $120 billion. The existence of such a large trade imbalance provides the United States with a great deal of leverage that President Trump has shown he is willing to use. China’s negotiators have obviously underestimated President Trump’s resolve to fundamentally change the direction of the Sino-U.S. relationship and his willingness to impose tariffs on all of China’s exports to the United States, if necessary, to achieve this goal.

However, the U.S. negotiators chose a very legalistic approach to addressing the IPR issue, an approach that seldom works in China. As anyone with experience operating in the country will attest, there are plenty of laws on the books in the country, the problem is enforcement.

At the same time, the U.S. negotiators underestimated the political sensitivity to foreign involvement in Chinese government affairs, striking a deep nerve in the country. A New York Timesarticle in March presciently explained how China’s “century of humiliation” that began with the “unequal treaties” of the 19th century after the first Opium War is “haunting” today’s trade talks between the two countries. While the reform-minded Chinese trade negotiators may have agreed to include IPR provisions in its laws in earlier rounds, the importance that China places on protecting its sovereignty obviously caused others in the country to take a different view.

For example, Chinese State Councilor and Foreign Minister Wang Yicommented that “China will always safeguard its sovereignty, [the] Chinese people’s interests, and national dignity when negotiating with any country.” An editorial in China Daily summarized why sovereignty concerns are so deep-seated in the country:

“…the US seems to take it for granted that tariffs are a weapon it can employ to bring China to its knees and extract one-sided concessions, apparently ignorant to the fact that China is not what it was in the late 1800s and early 1900s when the country was forced into signing humiliating treaties, which resulted in the opening of trading ports and paying of indemnities to Western powers.

“Feng Xiaoqing, an intellectual property law professor at the Civil, Commercial and Economic Law School in China is less combative and agrees that China needs to strengthen IPR protections for its own development. Nonetheless, Professor Feng also maintains that “China has to decide the rhythm of its legislation process.”

Enforcing whatever the two countries agree to with respect to IPR protections was always going to be the most difficult part of the trade negotiations. There are no easy ways to accomplish this goal without substantially changing behavior, but the United States seems to have chosen a path that is unlikely to work. Besides not being effective, the reason I am not as optimistic as I once was that the trade war will be successfully resolved in the short term is that the U.S. approach has also struck at a bedrock issue in China. Meanwhile, President Trump’s determination to restore balance and fairness in the relationship between China and the United States is a bedrock issue with him. As a result, he is willing to take steps in dealing with China that no country or U.S. president has ever contemplated.

In this sense, the negotiators on both sides are truly between a rock and a hard place. It is going to take a very creative compromise to bring the talks to a successful resolution, and the world may have to wait some time for such an agreement to appear.

]]>http://www.managingthedragon.com/?feed=rss2&p=28120Encouraging Signs in China’s Sluggish Auto Industryhttp://www.managingthedragon.com/?p=2796
http://www.managingthedragon.com/?p=2796#respondFri, 03 May 2019 16:33:36 +0000http://www.managingthedragon.com/?p=2796China’s vehicle sales declined for the 10th month in a row in March and fell by double digits during the first three months of the year. Despite this gloomy performance, however, encouraging signs are providing hope that the worst may be over for China autos.

After slowing throughout 2018, China’s economy has responded to recent stimulus measures, expanding by 6.4 percent in the first quarter, above expectations and at the top end of the 6.0 to 6.5 percent range projected for all of 2019. While the Trade War with the United States has not yet been resolved, talks between the two countries have been frequent and, by all accounts, productive in recent months, and an announcement may come as early as late May when China’s President Xi Jinping and U.S. President Donald Trump are expected on Trump’s trip to Asia. Responding to a stabilizing economy and the positive trends in trade talks, China’s stock markets have surged this year, with the Shanghai Index up 24 percent on the year. China stocks have now recovered almost all of the losses suffered in 2018’s market collapse.

Against this backdrop of a stabilizing economy, China’s vehicle sales have continued to be sluggish in the early months of 2019, following a weak 2018 when vehicle sales declined for the first time in memory. For the first quarter, total vehicle sales were down 11.3 percent year on year to 6.4 million vehicles, with passenger cars declining by 14 percent and commercial vehicle sales, led by trucks, registering a modest 2 percent increase over the previous year.

In an attempt to stimulate consumer demand, China’s National Development and Reform Commission (“NDRC”) released the draft of a broad-based “Plan to Stimulate Consumption of Autos, Home Appliances, and Consumer Electronics, and Promote Circular Economic Development (2019-2020)” earlier this year. Wang Yun, a researcher at the China Academy of Macroeconomic Research, which is affiliated to the NDRC, said that: “The plan targets short-and long-term consumption, and focuses on stabilizing large-scale products while also cultivating new drivers.” The plan’s objective is to optimize policies with respect to automobiles, housing and household appliances; to encourage consumption of green and smart appliances in urban and rural areas; and to unleash the potential of online shopping and tourism in China’s rural areas.

In order to signal the Chinese government’s continued strong support for the auto industry in general, and the purchase of New Energy Vehicles (NEVs) in particular, the draft addresses all aspects of auto demand. In the seven Chinese cities where license plate restrictions are in place, the draft proposes to end the license plate lottery for first-time automobile buyers. Recognizing that many young buyers in China’s Tier 3 and Tier 4 cities have been deprived of financing by last year’s collapse of many online lending platforms, the draft includes increased support for auto financing, especially in the country’s lower tier cities. In order to reduce the cost of purchasing a vehicle and encourage a switch to smaller vehicles, the draft proposes reducing the consumption tax on cars with 1.6-liter engines or less from 10 percent to five percent. Finally, in order to encourage the purchase of NEVs, the draft includes subsidies and personal tax credits for purchases of these vehicles, as well as a mandate that all taxis, ride-hailing fleets, and municipal vehicles must be NEVs.

As if taking a cue from the government, the exhibitors at the Shanghai Auto Show last month proudly displayed a plethora of new NEV models, and consumers demonstrated their support for the government’s initiatives in the first quarter with record purchases of NEVs. During the first three months of this year, NEV sales surged by 110 percent to 299,000 units.

At the start of 2019, the China Association of Automobile Manufacturers predicted that the country’s total car sales in the new year would be roughly the same as in 2018. Given events since then, auto observers are cautiously optimistic that vehicle sales will pick up in the second half of the year, and that the worst is behind the industry. That certainly was the sentiment of auto executives who spoke publicly at the Shanghai Auto Show which just ended.

Apart from the effects of the government’s stimulus measures, it is difficult to overestimate the positive impact on China’s economy — and auto sales — that a successful resolution of the Trade War with the United States will have. Autos are big-ticket items, and a high degree of consumer confidence is needed to have robust sales. Ever since President Trump announced last March that the United States would take multiple steps, including imposing significant tariffs on China’s U.S. exports, to protect American technology and intellectual property from discriminatory and burdensome trade practices, China’s economy, stock market, and currency have been under pressure. The onset of the Trade War had an immediate negative impact on consumer and investor sentiment, as consumers and investors alike worried that trade issues could lead to a broader split with the United States. As productive talks between the two countries resumed following the dinner between President Xi and President Trump in Buenos Aires on December 1, China’s stock market and currency began to recover.

All things considered, the stars seem to be aligned for a rebound in China’s auto industry. If nothing else, the trend seems to be headed in the right direction. After declining by 15.8 percent and 13.8 percent in January and February, respectively, auto sales were down by only 5.2 percent in March. However, given that China’s plan to stimulate consumption may only be implemented in May, auto sales in June may provide the first real indication as to how 2019 will shake out.

]]>http://www.managingthedragon.com/?feed=rss2&p=27960The Road Ahead For China’s Automobile Industryhttp://www.managingthedragon.com/?p=2790
http://www.managingthedragon.com/?p=2790#respondWed, 20 Mar 2019 21:03:39 +0000http://www.managingthedragon.com/?p=2790For the first time in memory, China’s unit vehicle sales declined in 2018, registering a 2.8 percent year over year decline. Although sales were cumulatively positive through September, they began declining on a monthly basis in July, and then completely fell out of bed in the last three months of the year. The industry’s downward trend has continued into this year, with vehicle sales declining by 17 percent in February, the eighth consecutive monthly sales decline. While two months of sales data is not necessarily dispositive for the year as a whole, China’s auto industry is clearly in a funk.

Vehicle sales in last year’s final quarter, and the rocky start to 2019, are worrying because the story in China’s auto industry over the past thirty years has been one of double digit annual growth. The continuing decline also raises questions about the industry’s prospects for 2019 and beyond. In order to form an opinion as to what lies ahead, it is first necessary to understand the causes for the industry’s poor recent performance. As might be expected, the answer is complicated, with a number of factors at work.

First and foremost, China’s economy began slowing last year, and a weakening economy always hurts sales of large capital goods items like autos. China’s Gross Domestic Product (“GDP”) grew by 6.8 percent in the first quarter, but then slowed to 6.7 percent in the second and 6.5 percent in the third. GDP grew by 6.4 percent in the final quarter of 2018, resulting in full year growth of 6.6 percent, the weakest in 28 years. The International Monetary Fund projects a further slowdown to 6.2 percent in 2019.

Second, China’s deleveraging campaign was a key reason for the economy’s slowdown, but it also hit consumer purchasing power particularly hard. From 2012 to 2017, China’s overall debt to GDP increased from 200 percent to 300 percent. At a three day, closed-door meeting in Beijing at the end of 2017, China’s leadership decided that lowering the economy’s financial risk would be an economic priority for the next three years. As a result of China’s resolve to reduce borrowings, credit has been tight, which, among other things, has caused the collapse of many online lending platforms, a big source of consumer loans for young auto buyers. Many of these young consumers are in China’s Tier 3 and Tier 4 cities where growth is needed for the industry to prosper.

A third factor is more technical in nature, and has to do with the reduction in 2016 of China’s consumption tax on purchases of smaller cars. In order to counter weak auto sales in 2015, China temporarily cut in half the 10 percent consumption tax on passenger cars with engines under 1.6 liters. At the end of the year, China’s Ministry of Finance announced that the tax on small-engine vehicles would increase to 7.5 percent in 2017, and then go back to the full 10 percent in 2018. The temporary tax cut had the desired effect and unit sales increased by 14 percent in 2016, but it came at the expense of sales in later years. According to Bernstein, a well-regarded Wall Street research firm that does a particularly good job covering the global and China auto industry, the cut in the consumption tax had the effect of pulling forward sales of 4 million units into 2016.

Finally, the trade war between China and the United States negatively impacted investor sentiment throughout the year, and created a great deal of uncertainty among investors and consumers as they worried that the dispute could have an impact well beyond trade. Accordingly, China’s Shanghai Composite Index declined by 26 percent during the year and was the worst performing stock market in the world. A loss of $2.4 trillion of stock market value further dampened consumer confidence.

With respect to 2019, most auto analysts are predicting a flat to down year in autos, depending to a great degree on government policies. Early credit and money data suggest that fiscal and monetary policies are easing, and at the National People’s Congress in March, Premier Li Keqiang announced a reduction in the Value Added Tax from 16 to 13 percent. Also, signs that the Trade War with the United States may be moving toward a successful resolution are having a positive impact on investor and consumer sentiment. As a result, China’s stock market has gone from worst to best, and is up over 25 percent so far in 2019. Bernstein sees early signs of a credit reversal in lower tier cities and the interior provinces – areas where credit availability was hardest hit in 2018 — and cites reports from industry contacts who believe that the worst may be over for retail demand.

On a long term basis, it is clear that the days of double digit unit sales growth in China’s auto industry are over. From 2001 when China joined WTO and the country was making 2.4 million vehicles a year, the industry has had a very good run to 28 million units in 2018. China is now the world’s largest auto market, by far, and accounts for about one third of all the vehicles produced globally each year. Solely due to the law of large numbers, it’s difficult to grow at double digit rates when the industry is already so large.

However, there are also signs that China’s auto industry may be nearing a saturation point as more autos appear on already crowded streets in China’s densely populated cities. Many more cities are following the lead of Beijing and implementing license restrictions in order to limit growth. After analyzing 100 years of global auto sales data, Bernstein found that, in market after market, an inflection point is reached when car ownership in a country reaches 160 cars per 1,000 people. When this penetration level has been reached, secular high growth in auto sales has transitioned to slower cyclical growth. Such a transition occurred in the United Sates in 1925, the United Kingdom in 1965, Japan in 1970, and Korea and Taiwan in the mid-1990s. China will reach 160 cars per 1,000 people in 2019 or 2020.

While the evidence suggests that China’s auto industry may be nearing a saturation point in the country’s large cities, the key to future industry growth may lie in China’s lower tier cities and interior provinces.

]]>http://www.managingthedragon.com/?feed=rss2&p=27900Listen to MTD’s New Podcast Series, “Managing The Dragon: Demystifying China”http://www.managingthedragon.com/?p=2783
http://www.managingthedragon.com/?p=2783#respondTue, 05 Mar 2019 22:37:41 +0000http://www.managingthedragon.com/?p=2783If you have not already done so, I would encourage you to sign up for our new podcast series, Managing the Dragon: Demystifying China on iTunes or Spotify. As discussed below, we have been adding new podcasts covering topical issues in the country that you will not want to miss.

At the start of this year, I made my five predictions for the New Year, just as I have done for each of the past 10 years. If you happened to miss my article, you may read it in its entirety here.

Given its importance, my first prediction dealt with the ongoing trade discussions between China and the United States. While many have been pessimistic about the outcome of these negotiations, I have been on record saying that the trade war will be successfully resolved and history by June 30. There are still many thorny issues to be addressed, and as Yogi Berra once famously said, “It ain’t over ’til it’s over,” but events appear to be playing out as we thought. As predicted, President Trump has extended the truce deadline, and three of my other predictions are also on track—China’s stock market has responded positively to the favorable trend in trade negotiations; China appears ready to step up purchases of everything from energy to soybeans from the United States; and China’s currency has remained steady at 6.7 yuan to the US dollar.

In order to address these and other issues, we have recorded three new podcasts. To supplement the article, we created a podcast that discusses my predictions for 2019 (Five Predictions for 2019), but also discusses how I fared on my predictions for 2018. We take a deeper dive into the trade war where I discuss the reasons for my optimism in a separate podcast on the subject (Trade War: Predictions). Finally, we review the key developments in China’s auto industry in 2018. For the first time in memory, auto sales declined in China last year. Our third podcast discusses the reasons why 2018 was the worst year on record for China’s automakers, but also underscores industry highlights such as China’s global leadership in electric vehicles and heavy duty trucks and identifies new opportunities in China’s auto aftermarket (2018’s Collapse in China Auto Sales: Review, Prognosis, and Opportunities).

]]>http://www.managingthedragon.com/?feed=rss2&p=27830Managing The Dragon’s 2019 Predictionshttp://www.managingthedragon.com/?p=2754
http://www.managingthedragon.com/?p=2754#respondThu, 31 Jan 2019 07:19:16 +0000http://www.managingthedragon.com/?p=2754“If you are going to be a bear, be a grizzly,” my father used to tell me. That’s the way I feel about going into 2019 with my five predictions for the New Year. Four of the five are dependent to a greater or lesser degree on the trade war between the United States and China being history by mid-year. If that happens, those four predictions will most likely hold up. If not, it will be a tough year.

For better or for worse, here goes.

Prediction #1: The trade war between the United States and China will be successfully resolved. While all of the issues between the two countries may not be resolved by March 1, the deadline for the truce will be extended as needed. By June 30, the trade war will be history.

Prediction #1 is not based on wishful thinking, but what I believe to be a realistic assessment of the facts.

The first is that the tempo of discussions between China and the United States suggest that the conflict is on its way to successful resolution. Tensions in the trade conflict peaked last September 24 when President Trump announced tariffs on an additional $200 billion of goods from China, saying that he was prepared to impose tariffs on all $500 billion of goods from the country. No meaningful discussions were held until the Buenos Aires dinner on December 1 that produced the current truce. In my more than 25 years in China, I have learned that no progress can be made unless both sides are talking. At this point, both sides are definitely talking.

The second is that there has been positive movement since the dinner. As part of the truce, the United States agreed not to increase tariffs on $200 billion of goods to 25 percent for at least 90 days. Meanwhile, China has already taken a number of positive steps. For example, China has agreed to label fentanyl a controlled substance and has reduced tariffs on cars built in the United States from 40 to 15 percent. In addition, China has resumed soybean purchases from the United States and has announced plans to give foreign companies greater access to its economy and to draft a replacement for its contentious “Made In China 2025” policy. Just before Christmas, a new draft law on foreign investment was submitted to the National People’s Congress that proposes a ban on forced technology transfer and illegal government “interference” in foreign business operations.

Earlier this month, North Korean leader Kim Jong Un happened to show up in Beijing while the U.S. trade delegation was in town. Following the meeting, President Xi Jinpingsaid that: China “encourages North Korea to continue in the direction of denuclearizing the (Korean) peninsula” and “supports a summit between North Korea and the U.S. to achieve results.” While discussions with Kim are separate from trade negotiations, China’s support for talks between the United States and North Korea are an important element in the overall Sino-American relationship.

Finally, both the United States and China are at a point where a successful resolution of the trade war will provide a significant boost to each country’s economy and stock market. At the time of the Buenos Aires dinner, China’s stock market was off by almost 21 percent since the onset of the conflict, and the renminbi was almost 9.0 percent lower against the dollar. Meanwhile, the U.S. stock market was up by almost 7.0 percent, and the dollar was stronger against the renminbi.

At that point, the impact of the trade war had not yet begun impacting the real economies. China’s exports to the United States were up by 8.0 percent through October, the latest month for which data is available, and China’s overall export growth accelerated from 9.8 percent in August to 14.5 percent in September, with analysts predicting that China’s exports would expand by 8.7 percent for all of 2018.

Impacted by signs of a slowing Chinese economy and the overhang of the trade war, China’s stock market sold off further in December, recording its worst performance in 10 years. Similarly, the threat of higher interest rates; a political stalemate over money for a border wall; concerns about a slowing Chinese economy; and the impact of the trade war on the Chinese and global economies led to a sharp selloff in the U.S. stock market in the final month of the year.

The two countries are now at a point where a successful resolution of the trade war would have a very positive impact on investor sentiment and the economies of both. The United States and China are now aligned, and both sides have a strong incentive to resolve the conflict

Prediction #2: China’s stock market will regain at least one-half of the ground it lost in 2018.

Over the past 10 years, I have on several occasions included a prediction about China’s stock market as one of my five, and every time I have succumbed to the temptation to do so, my prediction was either partially or totally wrong. Despite my resolution to never again make a stock market prediction, I am compelled to include one for 2019.

At the beginning of 2018, the Shanghai Stock Exchange Composite Index (“SSE”) was 3,392. By the end of the year, the SSE was 2,494, off 26.5 percent on the year and at its lowest level since November 2014. However, there are several reasons to believe that China’s stock market hit bottom last year.

Putting the trade war aside, which has had a definite, negative impact on investor sentiment, the government’s continuing deleveraging efforts adversely affected the Chinese economy last year. From 2012 to 2017, China’s overall debt to its Gross Domestic Product (“GDP”) increased from 200 percent to 300 percent, with corporate debt accounting for just more than one-half of total borrowings. At a three-day, closed-door meeting in Beijing at the end of 2017, China’s leadership made reducing financial risk an economic priority for the next three years. As a result of China’s resolve to reduce borrowings, credit has been tight; the country’s state-owned enterprises are being pressured to repay loans; many online lending platforms have collapsed, hurting consumer purchasing power; and margin debt on Chinese stock exchanges are at a low point and one-third of where they were in 2015.

With much of the negative news about China’s economy already baked into stock prices, the recent actions taken by China to stimulate its slowing economy and a successful resolution of the Trade War should provide impetus for a better stock market performance in 2019. While a 32 percent rise to recover all of the ground lost in 2018 may be too much to expect, a 449 point, or 18 percent, rise to 2,943 seems reasonable.

Prediction #3: U.S. exports to China will set new records and increase by 15 to 30 percent in 2019, depending on the date when the trade war finally ends.

Is China willing to help narrow the trade deficit with the United States in a meaningful way, and if so, does it have the ability to do so? The evidence suggest that the answers to both questions are “yes.”

Since 2015, U.S. exports to China have ranged from $115 billion to $130 billion. Based on exports through October, the latest month for which data is available, U.S. exports to China were somewhere around $122 billion in 2018. A 15 to 30 percent increase would add at least $18 billion, and as much as $36 billion to U.S. export sales, either of which would be an all-time record.

In 2017, China imported $1.8 trillion worth of goods from around the globe, including $129.9 billion from the United States. China was the third largest export destination for U.S. goods, and the leading export categories included agricultural products, aircraft, machinery, vehicles and electrical machinery. Our analysis of the data identified at least 30 product categories where the United States ranks among the top five global exporters, and where China ranks among the top five global importers. These 30 product categories alone account for over $500 billion of China’s imports. If Chinese companies were to switch just 10 percent of their annual imports of these products to U.S. suppliers, that would create additional exports of over $50 billion for U.S. companies.

Of all of the issues between the United States and China, the most quantifiable is the trade deficit. Voters in the United States will know very quickly whether the trade negotiations have produced tangible results by the export data, and China understands this dynamic. In an effort to short circuit the imposition of tariffs, Chinese negotiators proposed last June a package of U.S. farm and energy products, including soybeans, corn, natural gas, crude oil and coal, which China would buy and which officials from both sides valued at nearly $70 billion in the first year.

In December, Unipec, the trading arm of Sinopec, a state-owned, major oil company and China’s largest buyer of U.S. crude oil, reported that it is set to resume purchases from the United States very soon, and volumes are likely to be significant. As evidenced by Unipec’s announcement, China’s large state-owned enterprise (“SOE”) sector gives the country the ability to influence purchasing decisions to promote the interest of the country as a whole. In 2017, the assets of China’s SOEs totaled 72 trillion yuan ($10.5 trillion).

Prediction #4: The renminbi, China’s currency, will trade in a range of from 6.5 to 7.0 to the US dollar in 2019.

The exchange rate between the renminbi, or yuan, has been a bit of a roller coaster over the past several years. Heavy outflows of capital caused the yuan to weaken from 6.05 to the US dollar in January 2014 to 6.95 by January 2017. To counteract this outflow, China spent more than $1 trillion of foreign currency reserves to prop up the yuan, and in 2017, the government began restricting overseas acquisitions by Chinese companies. As a result, the yuan strengthened against the US dollar in 2017, reaching its high point of 6.34 to 1.0 in March.

With the onset of the trade war, the yuan weakened to nearly 7.0 to 1 at the low point of negotiations. With the declaration of the truce, the yuan has strengthened to its current level of 6.75, suggesting that a successful resolution of the conflict will have a positive impact on investor sentiment and the currency.

Even with a successful resolution of the trade war, it is difficult to see the yuan strengthen beyond 6.5 to 1 in 2019, though. Recent actions by the U.S. Federal Reserve System and higher interest rates in the United States have increased the attractiveness of dollar based assets. On the other hand, China seems to have drawn a line at 7.0 to 1 and is unlikely to allow the yuan to depreciate beyond that level.

Prediction #5: New Energy Vehicle (“NEV”) sales will reach 2.0 million units in 2019, widening China’s lead in the global electric vehicle industry.

In 2018, China’s sales of NEVs, which include battery electric vehicles, plug-in hybrids (“PHEVs”) and fuel-cell cars, nearly doubled to 1.2 million units, making China once again the clear leader in the global electric vehicle industry. Sales of NEVs in the United States also had an impressive increase of 81 percent to 361,000 units, but the U.S. market still trails China by a wide margin. Fueled by stronger expected sales of PHEVs, which grew by 140 percent last year, and the implementation of new Corporate Average Fuel Consumption (“CAFC”) standards, sales of NEVs in China will set another record and reach 2.0 million units in 2019.Growth of China’s NEV industry has been driven by a robust consumer subsidy program, which has provided cash subsidies to consumers of up to $10,000 per electric vehicle purchased. Because PHEVs have not been eligible for subsidies, hybrids have not been as popular with Chinese consumers.

In 2017, however, China announced its intention to phase out its subsidy program by 2021, replacing it with new CAFC targets and a combination of credits and dis-incentives designed to promote the deployment of NEVs in China. The new rules require automakers to produce fleets with a CAFC of 42 miles per gallon by 2020, and 54.5 miles per gallon by 2025. Beginning in 2019, automakers must earn points equivalent to 10 percent of the vehicles they produce in China and import into the country, rising to 12 percent in 2020. Under the new system, automakers earn super credits for the production of NEVs and energy saving vehicles. For example, passenger car models with a pure electric range of 50 kilometers are counted five times, and models with a combined fuel consumption lower than 2.8 liters per 100 kilometers are counted three times.

China’s new NEV policy will require all assemblers operating in China to produce and sell more NEVs, thereby shifting the burden of growing NEV sales from the government to the assemblers. The penalty for not being in compliance could be as drastic as the regulators suspending production of a company’s high-fuel-consumption models. Because hybrids improve an assembler’s CAFC and will no longer be disadvantaged in terms of subsidies, sales of hybrids can be expected to show particularly strong growth this year.

]]>http://www.managingthedragon.com/?feed=rss2&p=27540Apple’s Problem: China’s Economy or Loss of Market Share?http://www.managingthedragon.com/?p=2742
http://www.managingthedragon.com/?p=2742#respondSun, 13 Jan 2019 14:46:21 +0000http://www.managingthedragon.com/?p=2742At the end of the first day of trading in the New Year, Apple announced that it was cutting its revenue guidance. Tim Cook, Apple’s CEO, blamed a slowing Chinese economy and the impact of the trade war between the United States and China for the reduced guidance. In a letter to investors, Cook said:

“While we anticipated some challenges in key emerging markets, we did not foresee the magnitude of the economic deceleration, particularly in Greater China … China’s economy began to slow in the second half of 2018. The government-reported GDP growth during the September quarter was the second lowest in the last 25 years. We believe the economic environment in China has been further impacted by rising trade tensions with the United States.”

Is China’s economy really to blame for Apple’s shortfall as Cook claims, or is there another reason why Apple’s sales are hitting the wall in the country? While China is Apple’s third largest market by sales, there are growing signs that the company’s market share has slipped badly in recent years. Remember Motorola and Nokia? Both were early leaders in cell phones, not only in China, but also globally. Neither company exists today. The remnants of Motorola were purchased by Lenovo in 2014, and Nokia was purchased by Microsoft in 2013. Even big, successful companies can and do fail. It happens all of the time, particularly when strong market forces are at work like those in China today.

With respect to China’s economy, it is true that GDP growth is falling, but the “magnitude of the economic deceleration” is not nearly as large as Cook suggests. In the final quarter of 2017 and the first quarter of 2018, China’s economy grew by 6.8 percent. From there, it fell to 6.7 percent in the second quarter, and 6.5 percent in the third quarter, which happens to be China’s official, published growth target for the entire year. For 2019, the International Monetary Fund (“IMF”) has predicted that China’s economy would grow by 6.2 percent, down from an earlier forecast of 6.4 percent, citing the “negative effect of recent tariff actions.”

While tariffs may take 0.2 percentage points off of China’s growth rate in 2019, the impact of the trade war in 2018 has been more psychological in nature. Due to negative investor sentiment caused by trade tensions, the renminbi, China’s currency, is lower by about 8.0 percent against the dollar, and the Shanghai Stock Exchange closed the year 25 percent lower, its worst performance in 10 years. Meanwhile, in the real economy, exports to the United States have increased by 8.0 percent through October, the latest month for which data is available. Also, China’s overall export growth accelerated from 9.8 percent in August to 14.5 percent in September, with analysts predicting that exports will have expanded by 8.7 percent for all of 2018.

Rather than the trade war dragging down China’s economy in 2018 as Cook suggests, the deleveraging campaign that China began implementing in late 2017 is the major cause of the slowdown. In order to de-risk its financial sector, China has been restricting the overall growth in credit. This, in turn, has led to fewer loans available for corporations; the collapse of many online lending platforms; a greatly reduced level of margin debt; and a dramatic decline in shadow lending.

If not the economy, why are Apple’s sales in China slumping? It’s quite simple: more and more local competitors have come on the scene, and every year they, as a group, are producing more and better smartphones that are more affordable and that Chinese consumers want to buy.

As in most industries these days, the China smartphone market is one of the largest in the world. In 2017, there were approximately 660 million smartphone users in China, about one-third of the two billion users worldwide. In that year, there were 454.4 million smartphones shipped in the country, which means that Chinese users are replacing their smartphones about every eighteen months. Therefore, having new models and features is important. Of the smartphones shipped in China in 2017, Huawei was the clear leader shipping 102 million units, followed by OPPO and Vivo, with shipments of 77.6 million and 72.2 million units respectively. Apple was fourth with shipments of 51.1 million units, followed closely by Xiaomi with 50.1 million units. The top five companies accounted for 78 percent of the China market.

In 2015, a large number of new smartphone companies and models came onto the market, and consumers responded to the greater number of choices available by dramatically increasing cell phone purchases. With more competition and an expanded market, Apple’s market share declined from its peak of 13.6 percent in 2015 to 9.6 percent in 2016. In both 2016 and 2017, smartphone shipments by Huawei, OPPO and Vivo increased dramatically and their market shares expanded. Xiaomi’s market share slipped in 2016, but increased significantly in 2017. Meanwhile, Apple’s shipments have been relatively flat during this period, causing its market share to drift lower to 9.3 percent by the end of 2017.

In the third quarter of 2018, Huawei, OPPO and Vivo all increased unit sales over the second quarter — Vivo by 14 percent, OPPO by 7.5 percent and Huawei by 6.6 percent. Xiaomi’s unit sales slipped by 4 percent, while Apple registered a 10 percent decrease. Chinese consumers are still buying smartphones — they just aren’t buying Apple’s!

One of Apple’s problems is that its smartphones are at the high end of the market in terms of price, and this is especially challenging in China where consumers have a fundamentally different — and lower — cost perspective than consumers in the United States. Counterpoint, a technology research firm, has estimated that Apple has 79 percent of the global market for phones over $800. In China, Apple occupied 65 percent of the $600 or over segment, but only 11 percent of the market for handsets priced from $400 to $600. With Chinese consumers’ emphasis on affordability, and with smartphone users trading in their phones every 18 months, the market for lower priced phones is clearly growing much faster than the premium segment.

China’s lower cost perspective, in combination with the way in which the country has developed, has created two markets in the country — a purely local market that is characterized by low price and low technology, and a foreign/local market that is characterized by high price and high technology. Two key characteristics of China’s purely local market is that first, it keeps growing, and that secondly, the local companies don’t just stand still. Many improve their quality and technology. Apple has clearly been focused on the foreign/local market where it is at a comparable price point with Samsung.

Meanwhile, the companies competing in the purely local market for smartphones have been growing their sales and developing their products. Just like in appliances, passenger cars and almost every other product being made in China today, the local companies are making better and better products that are more affordable than the products made by their international competitors. Among the local companies, for example, Huawei is leading the way in the development of 5G technology, an area where Apple has lagged. The ultimate challenge for Apple will occur when the Chinese smartphone makers take their more affordable products and begin to compete in Apple’s markets outside China. Maybe that’s what the stock market was worried about when it slashed Apple’s market value by $57 billion?

In summary, Apple’s problem in China is not simply a slowing Chinese economy as Cook suggests. Smartphone shipments in China have been falling for at least six quarters. With an already high smartphone penetration rate, the market is saturated, and Chinese consumers have been watching and waiting for the development of new features like 5G. With respect to Apple itself, the company’s products are too high priced for the bulk of the China market where the competition is only getting stronger. Finally, in a market where users are constantly upgrading their phones, Apple has not done a particularly good job as far as introducing new products and innovations. The net result has been a significant loss of market share in the world’s largest market for smartphones.

]]>http://www.managingthedragon.com/?feed=rss2&p=274202018 Predictions: How Did We Do?http://www.managingthedragon.com/?p=2720
http://www.managingthedragon.com/?p=2720#respondFri, 04 Jan 2019 16:00:38 +0000http://www.managingthedragon.com/?p=2720A number of key events shaped 2018, impacting both China and the United States as well as the relationship between the two countries. First ever meetings among the leaders of North Korea, China and the United States took place. The United States and China became embroiled in a Trade War that flared up in March and grew in intensity until a meeting between U.S. President Donald Trump and China President Xi Jinping in early December produced a temporary truce. And, China implemented a deleveraging program in an effort to “de-risk” its financial system that slowed growth in key sectors of its economy such as autos.

The cumulative effect of these and other events took a toll on the stock markets of both countries, each of which had their worst performances in ten years. When the Closing Bell rang at the end of the year, the Shanghai Stock Exchange Composite Index was off 25 percent, and the Dow Jones Industrial Average had declined by just over six percent.

Despite the volatility of 2018, Managing The Dragon (MTD) fared pretty well on its predictions for the year. Of the five predictions made on January 23, four — growth in China’s exports to the United States; the pace of overseas acquisitions by Chinese companies; tensions on the Korean Peninsula and sales of New Energy Vehicles (NEVs ) — played out more or less as MTD predicted. The only prediction that did not turn out as expected was the value of the renminbi against the U.S. dollar, which fell by more than eight percent from its high, and closed the year at 6.9 to 1.0. MTD predicted the yuan would remain stable at 6.5 to the U.S. dollar.

Following in a tradition that was first established with MTD’s review of its 2009 predictions, MTD will once again review each of its predictions in detail, and award a score of from one to 20 points for each, depending on how we think we did. You may agree or disagree with the scores we assign, but we hope to at least score some points with you for our transparency and accountability.

Prediction #1: After exceptionally strong growth in 2017, China’s exports to the United States will once again break records in 2018.

In 2017, China’s exports to the United States increased by 9.3 percent, following a 4.3 percent decline in 2016. Reversing 2016’s decline, and achieving significant growth from an already large base, China’s U.S. export performance in 2017 to record levels was nothing less than impressive.

One of the biggest factors influencing the level of imports into a country is the health of the importing economy. History shows that the larger and more developed an economy becomes, the more it imports. Given the way in which factories in China have been integrated into the global supply chain, the economies of the world’s two largest trading partners are inextricably joined at the hip. As the U.S. economy has grown, so have China’s exports to the United States.

In 2015, the U.S. economy grew by 2.9 percent, and China’s exports to the United States grew by 3.1 percent. In 2016, the U.S. Gross Domestic Product (GDP) growth rate fell to 1.6 percent, and China’s U.S. exports fell by 4.3 percent. In 2017, the U.S. GDP growth rate increased to 2.2 percent, which led to the record level of imports from China in that year.

With that pattern in mind, and with the expectation of a stronger U.S. economy in 2018, MTD predicted that China’s exports to the United States would once again break records. Following 2.2 percent GDP growth in 2017 and the first quarter of 2018, the U.S. economy grew by 4.2 percent in the second quarter and 3.5 percent in the third.

With a stronger U.S. economy, China’s exports to the United States also grew, increasing by 8.3 percent through October, the latest month for which figures have been published. While it may be argued that 2018 export figures were favorably impacted by pre-buying in advance of more and higher tariffs in 2019, it is noteworthy that China’s U.S. exports for every month last year, including the months that pre-dated the onset of the Trade War, were higher than the figures for the same month in 2017.

For Prediction #1, MTD believes it deserves the full credit of 20 points.

Prediction #2: China will maintain the value of the renminbi at approximately the current exchange rate of 6.5 to 1.

Prediction #2 fell victim to the trade war.

The exchange rate between the renminbi or yuan, China’s currency, and the US dollar has been a bit of a roller coast ride in recent years, heavily influenced by the Chinese government’s efforts to control the outflow of capital from the country. An overseas acquisition binge by Chinese companies in 2015 and 2016 resulted in heavy outflows of capital during those years and caused the yuan to weaken from 6.05 to the U.S. Dollar in January 2014 to 6.95 by January 2017.

In 2017, China began restricting outbound M&A, and the yuan strengthened to 6.49 against the US dollar by Januar, 2018. Going into the New Year, and expecting another record year of exports to the United States, MTD believed that China’s leaders would be particularly sensitive to charges of currency manipulation and would do all in their power to keep the currency stable at 6.5 to 1.

Instead, negative investor sentiment caused by the trade war, coupled with interest rate increases by the U.S. Federal Reserve, has made US dollar assets more appealing for investors. As a result, China’s currency began seriously weakening in June and closed the year at 6.9 to 1.0.

Unfortunately, MTD whiffed on Prediction #2 and gets no points for this one.

Prediction #3: In the face of strong export growth, China will continue to restrict overseas investment. As a result, overseas acquisitions by Chinese companies will be flat to down in 2018.

Spurred by the desire on the part of Chinese companies to be global, as well as favorable government policies that encouraged Chinese companies to go abroad, overseas acquisitions by Chinese companies surged in 2016 and Chinese companies became important players in global mergers and acquisitions (M&A). Combined with weak exports, the heavy outflow of capital that resulted caused a significant weakening of the renminbi. In order to prop up its currency, China began dumping U.S. Treasuries at the end of 2016, using the dollars received to buy the yuan, draining the country’s foreign currency reserves in the process.

To stem the capital outflow, China imposed restrictions on overseas investment in 2017, which it tightened as the year progressed. As a result, China’s outward direct investment dropped 19.3 percent in 2017, marking the first decline recorded since 2002 according to a report from China’s Ministry of Commerce, National Bureau of Statistics and State Administration of Foreign Exchange. Given the Chinese Government’s focus on the stability of its currency, MTD believed that the government would continue to discourage overseas acquisitions by Chinese companies and that overseas M&A would continue to be weak in 2018.

With the onset of the trade war and the resulting weakness in the yuan, the Chinese government has, in fact, continued its restrictive measures on overseas acquisitions. In addition, US concerns with respect to the theft of intellectual property by Chinese companies has caused the Committee on Foreign Investment in the United States (“CFIUS”), the interagency committee authorized to review certain transactions involving foreign investment in the United States, to closely scrutinize U.S. acquisitions by Chinese companies.

As a result, the value of Chinese outbound M&A plunged by 61.2 percent in the first half of 2018, according to a report by Bain & Co., a business consultancy, with U.S. transactions particularly weak. “For the near future, it makes sense to put U.S. acquisition plans on hold,” Bain’s report said. “As a short-term measure, many are now pivoting to Europe and other non-U.S. developed markets” to buy companies that have the technology they need. Deal activity in 2018 will fall well short of the levels achieved in 2016, according to a Bloomberg report,

MTD scored another 20 points for Prediction #3.

Prediction #4: The situation with North Korea will come to a head in 2018, and China will play a constructive role, albeit behind the scenes, in the successful resolution of the crisis on the Korean Peninsula.

MTD went way out on a limb with its prediction for North Korea.

At this time last year, North Korea was reportedly within months of being able to arm ICBMs with nuclear weapons, and false alarms about incoming missiles in both Hawaii and Japan demonstrated how nervous citizens in the United States and the rest of the world had become with the prospect of a nuclear North Korea. In an interview on the subject, John Kelly, President Trump’s Chief of Staff at the time, said that, with respect to North Korea, the United States has kicked the can down the road for the past twenty-five years. “The problem at this point in time is there’s no road left. We have to deal with this guy,” Kelly concluded. Taking General Kelly at his word, MTD believed that the situation on the Korean Peninsula would come to a head in 2018 and that China would play an important role behind the scenes in the discussions.

As far as trade, it is always difficult to determine precisely what is actually happening between China and North Korea. While there are periodic reports of Chinese and North Korean ships secretly exchanging cargoes at sea, the numbers appear to tell a different story. Chinese exports to North Korea totaled $1.6 billion from January to September 2018, down 59.2 percent from the previous year, according to Beijing’s customs office. North Korea imports into China totaled $144.6 million, down by 90.1 percent from January to September. While some suggest that China might be manipulating the numbers, trade between the two countries is at such minuscule levels that it is difficult to see how even gross exaggerations would make much of a difference.

Apart from trade, China’s most important contribution to the talks between the United States and North Korea may be the “Big Brother” role that China’s President Xi has played to North Korea’s Kim Jong Un. On June 12, President Trump met in Singapore with Kim, the first between a North Korean leader and a serving U.S. President. Prior to that meeting, Kim made a surprise visit to Beijing in late March and to the northeastern city of Dalian in May, presumably to seek guidance from President Xi. For the first six years of his rule, Kim did not leave his country, even to visit with China, North Korea’s only real ally. At their third meeting in as many months, Kim met with President Xi again on June 19, just one week after Kim’s historic summit with President Trump.

Of course, we can only speculate as to what President Xi said to Kim in their three meetings, but it is safe to say that Xi was nothing if not supportive, which in and of itself may have made Kim feel less isolated and improved the climate for negotiations with the United States. China has an important geopolitical stake in seeing that the crisis on the Korean Peninsula is resolved peacefully and has largely supported the diplomatic discussions between Washington and Pyongyang, even supplying Kim with an Air China plane for his journey to Singapore. China’s state-run television, Xi lavished praise on Kim for his handling of the U.S. meeting and said he was very pleased both with the results of Kim’s Singapore talks as well as North Korea’s future goal of economic development, according to CCTV. The two men agreed to further deepen the already-close ties between Pyongyang and Beijing, according to state media.

The crisis with North Korea is far from over, but talks between the United States and North Korea have produced some positive results, most notably a one-year halt in missile testing by North Korea; a thawing of the relationship between North and South Korea; and the return of the remains of U.S. soldiers killed or captured in North Korea during the Korean War.

Given the lack of transparency from two of the world’s most mysterious countries, it is difficult to determine exactly what role Beijing has played in the discussions between the United States and North Korea. However, MTD continues to believe that President Xi and China have played an important, behind the scenes, role in supporting discussions between the two countries. As a result, MTD will take 20 points for Prediction #4.

Prediction #5: China will break the 1.0 million mark in sales of New Energy Vehicles (NEVs) in 2018.

The combination of China’s large number of densely populated cities and rising per capita incomes is creating a demand for better personal transportation alternatives that cannot be met in an environmentally sustainable way using vehicles powered by an internal combustion engine (ICE). With all of the growth experienced by China’s auto industry over the past 25 years, there is still less than one car for every six individuals in the country, compared to the United States where there is nearly one car for every man, woman and child. Under these circumstances, China simply has no choice. The country must either accept a growing number of ICE-powered vehicles, with all that implies as far as air pollution and energy dependence; restrict the transportation choices of its citizens; or embrace new technologies such as NEVs.

As a result, China has been supporting the development of NEVs with consumer subsidies, which are now being phased out and replaced by mandated NEV production targets for all assemblers operating in the country, as well as tough, new Corporate Average Fuel Economy standards. Despite China’s overall sluggish auto market in 2018, just over one million NEVs were sold in China in the first 11 months of the year, up 68 percent from the same period in 2017, according to data from the China Association of Automobile Manufacturers. For the full year of 2018, it is estimated that 1.2 million NEVs will be sold in China. This does not include an estimated 1.3 million affordable Low Speed Electric Vehicles that are used extensively in China’s Tier 2 and Tier 3 cities.

If anything, MTD was too conservative in its prediction for NEV sales in 2018. However, that will not prevent us from taking full credit, and 20 points, for Prediction #5.

2018 marked the 10th year that MTD has made five New Year Predictions, and then graded itself at the end of the year. Over the years, MTD’s scores have ranged from a low of 43 in 2011 to a high of 85 in 2015. During these 10 years, 2018 is the third year in which MTD has achieved a score of 80. With one of our most successful years of predictions behind us, MTD is ready to make its predictions for 2019. Stay tuned, and Happy New Year to all of our readers.

]]>http://www.managingthedragon.com/?feed=rss2&p=27200The Trade War Truce — Who Benefits?http://www.managingthedragon.com/?p=2713
http://www.managingthedragon.com/?p=2713#commentsSat, 22 Dec 2018 20:56:19 +0000http://www.managingthedragon.com/?p=2713The answer might surprise you. Two of Germany’s largest car makers stand to be immediate beneficiaries of a reduction in trade tensions between the United States and China. Currently, the United States exports more cars to China than China exports to the United States, and BMW AG and Daimler AG lead the way with their American made cars. Over the years, both companies have invested heavily in the United States to build factories that supply not only the U.S. market but also the export markets, including China.

In 2017, U.S. manufacturers exported almost 270,000 passenger cars worth $9.5 billion to China, but only imported 58,000 vehicles worth $1.5 billion from the world’s largest car market. Of the units exported to China by U.S. car manufacturers, BMW and Daimler accounted for 67 percent of the total. Ford was third, exporting nearly 45,000 cars to customers in China. While the $8.0 billion trade surplus that the United States enjoys with China in autos is a small portion of its overall trade deficit with the country, autos are big-ticket items that create high paying jobs.

BMW first came to the United States in 1975 when it established BMW North America in Woodcliff Lake, New Jersey. In 1994, BMW opened its first full manufacturing facility outside Germany and its first U.S. production facility in Spartanburg, South Carolina. Since opening the plant, BMW has invested over $9 billion in the 1,150-acre, 7-million-square-foot campus that now employs more than 10,000 people. In 2017, BMW exported over 270,000 X3, X4, X5, and X6 models, more than 70 percent of Spartanburg’s total production volume of 370,000 units, making BMW the largest U.S. exporter of vehicles. In 2017, BMW also leads the way in auto exports to China, sending over 100,000 units to Chinese customers from Spartanburg.

The second largest U.S. exporter of passenger cars to China in 2017 was Mercedes Benz USA (“MBUSA”), a unit of Daimler, which exported over 72,000 Mercedes-Benz GL, GLE, GLS, and R-Class models. Headquartered in Atlanta, Georgia, MBUSA also has a long history in the United States. The company was formally established in 1965 but began selling Mercedes-Benz vehicles in America as early as 1952.

MBUSA first established its U.S. manufacturing operations in 1995 when it opened a factory in Tuscaloosa County, Alabama. With production of more than 310,000 vehicles, the Tuscaloosa facility is now the worldwide production location for the GLE, GLS and GLE Coupe SUVs, as well as for the C-Class sedan for North America. Since its opening, MBUSA has invested more than $6 billion in Tuscaloosa and now employs more than 3,700 and supports over 10,000 jobs at suppliers and service providers throughout the region. In April of 2018, MBUSA announced an additional $1 billion investment in its Alabama plant.

Because the luxury vehicles produced by BMW and MBUSA are big-ticket items, tariffs are an important consideration as the two companies develop their global supply chain strategies. Generally, auto companies prefer to produce their car models in the markets where they are actually sold, which is why both BMW and Daimler have established assembly plants in China. In addition to tariffs and being close to the consumer, however, plant utilization, economic factors, and customer preferences are also important considerations.

For example, foreign ownership of Chinese assembly operations has been limited to 50 percent until recently. While this restriction will go by the wayside in 2022, international car companies need to take into account the fact that profits from cars made in a joint venture are shared with their Chinese joint venture partner. Also, Chinese customers often prefer and will pay a premium, for products that have the “Made In USA” label, even though the same product may be available from a Chinese joint venture. This is particularly the case with luxury automobiles.

When exporting cars to China, an import duty, a Value Added Tax (“VAT”) of 16 percent, and a Consumption Tax of between 1 and 40 percent, depending upon the size of the engine, are added to the price of the vehicle. (It should be noted that cars made and sold in China are also subject to the VAT and Consumption Tax.) Up until July 1, 2018, when China reduced the tariff on car imports to 15 percent, vehicles imported into China were subject to a 25 percent import duty. However, when President Trump increased the tariff on cars imported from China into the United States from 2.5 percent to 27.5 percent on July 6, President Xi of China raised the tariff on cars from the United States from 15 percent to 40 percent.

As a result of the 90-day truce agreed upon by the leaders of world’s two largest economies after their recent meeting in Argentina, China announced over the weekend that it would reduce the tariffs on cars imported from the United States to 15 percent during the 90-day period ending March 31, 2019. BMW and MBUSA reacted immediately to China’s announcement. On Saturday, BMW announced 4 percent price cuts for models, including the X5 sport utility vehicle, imported from its U.S. plant.

On Monday, MBUSA said it would offer discounts on cars imported into China from the United States until March 31, cutting prices of four models by between 36,000 yuan ($5,220) and 135,000 yuan ($19,565).

While the trade war between the United States and China is creating near-term uncertainty with companies and consumers alike, the long-term impact may be positive if the truce is followed by a more lasting compromise. To the extent that tariffs on autos sold to China remain at 15 percent, and are perhaps reduced even further, companies like BMW and Daimler with global supply chains will be major beneficiaries.

]]>http://www.managingthedragon.com/?feed=rss2&p=271312018: A Transition Year for China Autos?http://www.managingthedragon.com/?p=2709
http://www.managingthedragon.com/?p=2709#respondMon, 26 Nov 2018 18:36:07 +0000http://www.managingthedragon.com/?p=27092018 may be shaping up to be a transition year for China automobiles. It may be the year that marks the end of the industry’s nearly 20-year growth phase, and the beginning of a mature phase where vehicle sales grow in line with overall economic factors. According to the China Association of Automobile Manufacturers (CAAM), vehicle sales fell by 11.6 percent to 2.4 million units in September, the third straight monthly decline this year. Even SUVs, the best performing category in recent years, saw unit sales drop by 10.1 percent in the month.

For the first nine months of the year, total vehicle sales eked out a modest 1.5 percent gain to 20.5 million units. Passenger car sales grew by 0.6 percent to 17.3 million units, while sales of commercial vehicles grew by 6.3 percent to 3.2 million units. Within the passenger car segment, sedans accounted for 49 percent of sales, growing by 1.3 percent to 8.4 million units, and SUVs accounted for 42 percent, growing by 3.9 percent to 7.2 million units during the period. Fueled by 13.3 percent growth in light truck sales, trucks were the strongest performing category overall, increasing by 7.6 percent to 2.9 million units

Other than trucks, the only other bright spot was new energy vehicle (NEV) sales, which increased by 81.1 percent to 721,000 units. With respect to NEVs, government policies are affecting not only the growth but also the structure of this industry sector.

Under the old system of subsidies, plug-in hybrid electric vehicles (PHEVs), unlike “all-electric vehicles” (EVs), were not eligible for subsidies, reducing their appeal to Chinese consumers. Under the country’s new NEV policies that went into effect in 2017, however, consumer subsidies are being replaced by fuel consumption targets for manufacturers. Because they lower a vehicle fleet’s average fuel consumption and help the manufacturer to meet the government’s targets, PHEVs are now in favor. During the first nine months, EVs grew by 66.2 percent to 541,000 units, but PHEVs grew even faster by 146.9 percent to 181,000 units.

Despite the strong performance of light trucks and NEVs, the consecutive monthly declines in total vehicle sales during the third quarter have caused many industry observers to re-evaluate their projections for industry growth. Some worry that the world’s largest auto market could contract in 2018 for the first time since the 1990s. Xu Haidong, CAAM’s Assistant Secretary-General, believes that the market will avoid a sales decline, but does not believe that it will meet CAAM’s earlier prediction of 3.0 percent growth.

A slowing economy, Beijing’s deleveraging initiative, a collapse in online lending, higher gasoline prices and a tough crackdown on pollution have all been cited as reasons for a softer automobile market in 2018. All of those factors have certainly had an impact on sales, but the sentiment is growing that the China auto market may already be reaching a saturation point.

With 276.1 million trucks, buses and passenger cars in its vehicle population, providing 857 vehicles for every 1,000 people, the United States is arguably the world’s most mature auto market. Even though China leads the world in terms of annual auto sales, its population of 217.0 million vehicles provides just under 155 vehicles for every 1,000 Chinese. Due to the large disparity in vehicles per capita between the two countries, the conventional wisdom has been that China’s auto industry has substantial room to grow before it approaches the number of vehicles per capita in the United States. However, this argument does not take into account the fact that China, with its large population and a high percentage of uninhabited landmass, has a much higher level of urban density than the United States.

A recent report by Bernstein, a well-regarded research firm that closely follows China’s auto industry, further develops this argument. According to Bernstein, the Chinese auto market is now nearing maturity as the penetration of automobiles in the country approaches 160 cars per 1,000 people. After analyzing 100 years of global auto sales data, Bernstein found that in market after market, an inflection point is reached when car ownership penetration in a country reaches 160 cars per 1,000 people. When this penetration level has been reached, secular high growth in auto sales has transitioned to slower cyclical growth. Such a transition occurred in the United States in 1925, the United Kingdom in 1965, Japan in 1970, and Korea and Taiwan in the mid-1990s. China will reach 160 cars per 1,000 people in 2019 or 2020.

As further evidence that a fundamental shift in the outlook for China auto sales is occurring, Bernstein notes that most of China’s Tier 1, Tier 2, and Tier 3 cities are now “full of cars.” In 2017, Beijing had car ownership penetration of 260 cars per 1,000 people, while the top 10 cities averaged 251 cars per 1,000 people. At these levels, many local governments have deemed it necessary to restrict car sales in their cities, with Beijing taking it a step further by restricting the size of the total fleet in the country’s capital city. Finally, Bernstein notes that growth in licensed drivers in China has slowed in recent years, and this is a further sign that China’s auto industry is reaching maturity.

Only time will tell whether Bernstein is correct, or whether weak auto sales in 2018 are merely the result of a combination of adverse economic factors. In any case, the industry’s performance in 2018 is giving all auto assemblers and industry observers pause for reflection.

]]>http://www.managingthedragon.com/?feed=rss2&p=27090Happy Thanksgiving to MTD’s Readershttp://www.managingthedragon.com/?p=2703
http://www.managingthedragon.com/?p=2703#respondThu, 22 Nov 2018 06:26:12 +0000http://www.managingthedragon.com/?p=2703Having lived in China for most of the past 25 years, one question I’m frequently asked is: “What about the United States do you miss most?” For my wife and me, the answer to that question is easy—the holidays. On the Fourth of July, Memorial Day, or Labor Day, when everyone in the States is taking a long weekend and firing up the barbecue, it’s just another workday for us in the office.

One holiday that Carleen and I miss most is Thanksgiving. In many ways, Thanksgiving is the best of all U.S. holidays. Like Christmas, it’s all about family, but it’s not at all commercial like Christmas has become. It’s a time to be with friends and family, have some great food, relax and watch some football.

Despite this, Carleen and I have never made it back to the States for Thanksgiving over the past 20 plus years. Although it’s one of our favorite holidays, the time between Thanksgiving and Christmas is so short, that it doesn’t make sense to make the 26-hour round trip twice in two months. Given our druthers, we have always opted for being home for Christmas and New Year’s instead.

One of my most vivid memories of our early days in China is our first Thanksgiving, which we spent in the industrial city of Wuhan in the middle of the country. It was an intense period back then as we were learning about China, and we were so focused on building ASIMCO that we both tended to lose track of the holidays. Only by calling the office of one of our partners in the States the day before a long holiday weekend and finding everyone gone for the day, for example, might we realize that “Oh, it’s Labor Day weekend in the States.” For this reason, it was not unusual for me to inadvertently schedule factory visits around the city of Wuhan on Thanksgiving Day in 1993.

As we boarded our plane in Beijing on Wednesday afternoon, only then did it dawn on Carleen and me that we were going to spend Thanksgiving in Hubei province — a depressing thought that was a bit of a downer for the entire flight. As we pulled up to our hotel, though, our mood brightened considerably. A large sign draped above the front door proclaimed: “Join Us For Thanksgiving Dinner.” Underneath, in smaller letters, it elaborated: “Turkeys Imported from the U.S.”

Encouraged by this unexpected greeting, I turned to Carleen, and in my best attempt at reassurance, said: “See, this won’t be so bad.” We didn’t waste any time making our dinner reservations, and we both looked forward to getting back to the hotel after our factory visits the next day.

Despite the hundreds of millions of ducks and chickens that are raised in China each year, turkeys have never caught on. Most Chinese have never had turkey, even though it is really not that dissimilar to chicken or duck, which are favorites here. Carleen’s theory is that the typical Chinese oven is not large enough to accommodate the much larger bird. That may be — I have never heard a better explanation. Whatever the reason, though, the fact that turkeys are not raised in China means that they have to be imported. And that is what our hotel was advertising.

During the next day’s factory visits, it was difficult to keep our minds from wandering to the turkey dinner that we were going to have that evening. You can imagine our disappointment when we arrived at the hotel restaurant, only to be told that the flight carrying the shipment of turkeys had been canceled. Like millions of other Chinese that evening, we ate duck.

From that point on, Carleen was determined never again to miss a Thanksgiving Day celebration. Every year, we hosted Thanksgiving dinner for our friends at our apartment in Beijing. At first, Carleen had to order the turkey months in advance, but now many stores carry them and they are in abundant supply. The guest list has grown in size over the years so that we now cook two turkeys, and it has become somewhat of an international affair. Many of our friends in Beijing are from Europe, Australia, Japan, China or other parts of the world and have heard of Thanksgiving, but don’t really know what it means. We enjoy telling them, they enjoy hearing about it, and we all enjoy the celebration.

Tonight we celebrate our first Thanksgiving in the United States after 23 in China, beginning with that first one in Wuhan. Thanksgiving, whether celebrated in the United States or China, is always a good reminder of the many things we all have to be thankful for.